The euro’s decline has only just begun – here’s how to profit

published 8 November 2013

13-11-08-draghi — Mario Draghi: means business

The euro's recent winning streak came to a very decisive end yesterday.

Mario Draghi, the head of the European Central Bank (ECB), gave markets a bit of a shock.

Just as investors were starting to wonder if the ECB chief could really deliver on his promises to save the eurozone, he surprised them all by cutting rates.

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The euro tanked, and for about five seconds, everyone even forgot about the fact that Twitter was going public over in the US.

So what does Draghi's surprise attack mean for your money?

The central banker's secret weapon

These days everyone expects central bankers to lay their next moves out on a plate for investors to digest. So it's easy to forget that one of the most important tools a central banker has is the element of surprise.

If investors know what you plan to do next, it's very hard to create an impact, or make a point. So sometimes you have to give them a bit of a shock.

That's what Mario Draghi did yesterday. Very few pundits expected a rate cut from the European Central Bank (ECB). But that's what they got from 0.5% to 0.25%. On top of that, Draghi also promised an extra year's unlimited lending to banks in the eurozone.

On a eurozone-wide basis, the annual inflation rate has fallen to 0.7%. That gave Draghi all the excuse he needed to cut the ECB's inflation target is 2%. But investors had started to worry that his hands were tied.

That's why this cut matters. It doesn't have that much impact in practical terms at least, not on banks' ability to lend at cheap rates. But it does show that Draghi means business. It shows that his promise to "do whatever it takes" to protect the eurozone wasn't just some phrase trotted off in the heat of the moment.

It also shows that the print more money' end of the eurozone the troubled southerners holds more sway with the ECB than any German concerns about burgeoning inflation. Indeed, Jens Weidmann, the president of the German Bundesbank, was among the few who voted to hold rather than cut rates.

Neither side is necessarily more right' than the other, despite the way that many columnists present it. It's understandable that the Germans don't want to adjust their economic model, any more than the Greeks want to change theirs.

But this is what happens when you give up your economic sovereignty to share a currency with other nations.

The Greeks have to become more like the Germans: grow more efficient, less politically corrupt, and occasionally pay some tax. But the Germans also have to become more like the Greeks: consume a bit more, and focus a bit less on manufacturing. Either that, or when the Greeks run into trouble, the Germans have to accept that German taxes will be spent on propping them up.

This, as we've noted before, is the fundamental problem at the heart of the eurozone. Ordinary citizens didn't quite realise that this mutual dependence is what they were signing up for when they joined the euro or even if they did, in most cases they weren't given a choice on the matter.

Politics dictates the easiest way to deal with the eurozone crisis

Of course, with the German elections behind us, and the Greeks voting to stick with the euro last year, the politics have now faded into the background somewhat.

But the fact remains that the biggest threat to the eurozone's continued existence is that the people decide that they don't want the euro anymore. And that's why responsibility for dealing with the eurozone crisis has been dumped squarely on the ECB.

Handing more money direct to the banks isn't on that'd annoy people. Giving German money direct to the Greeks isn't an easy sell either. So the easiest, least transparent option is to try and inflate away the debt problems and boost nominal growth in weaker countries, by eroding the value of the euro.

The truth is, it's not a lot different to the policy that every other developed country in the world is trying to follow. The added complexity for Draghi has been that when he first became head of the ECB, the euro was tumbling because markets genuinely believed it would disintegrate.

So arresting the currency's decline was vital to show that the euro remained a viable form of money, with the full support of the central bank behind it.

But now that the immediate fear of Europe disintegrating is past, Draghi would positively welcome a weaker euro. And given that it's the least painful option politically, he'll have the tacit approval of Europe's leaders in doing so.

And given that Europe's banks are in a bigger mess than anyone's both the US and the UK are further ahead in terms of dealing with their problems you can expect the ECB to be the easiest' money central bank for some time to come.

What does this mean for your money?

As my colleague Matthew Partridge recently pointed out, you can play this in a number of ways. You can invest in the cheaper-looking eurozone stock markets weaker monetary policy will be good for them in the longer run.

If you're interested in currency trading, you could look at shorting the euro, but do remember that spread betting is highly risky. Also bear in mind that today the US jobless data comes out, which is likely to make markets very volatile in the short term at least. If you want to know more about trading, you can sign up for my colleague John C Burford's MoneyWeek Trader email free.

And before I go in this week's MoneyWeek magazine, we've teamed up with the BBC's Panorama programme to take a look at the property market and the impact of Help to Buy. You can read our Roundtable in this week's issue, out now (if you're not already a subscriber, subscribe to MoneyWeek magazine). And watch the Panorama programme on the topic, on BBC 1 at 8:30pm on Monday.

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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.